A market maker for an asset (security, currency, option, etc.) is traditionally a person or firm who will quote both a bid and an ask price on the asset whenever asked to do so. The bid is the price at which the market maker is prepared to buy and the ask is the price at which the market maker is prepared to sell. Typically, at the time the bid and ask are quoted, the market maker does not know whether the trader who asked for the quotes wants to buy or sell the asset. The ask is higher than the bid, and the amount by which the ask exceeds the bid is referred to as the bid-ask spread. The existence of the market maker ensures that buy and sell orders can always be executed at some price without delay. Thus, market makers add liquidity to the market in which they participate.
Market makers make their profits from the bid-ask spread. Thus, the spread must be large enough to cover a market maker's risks, but small enough to compete with spreads offered by other market makers. To reduce their exposure to losses, market makers utilize a variety of risk-reducing strategies, collectively referred to herein as hedging. The more accurately risk can be assessed, the smaller a market-maker can make the spread. A market maker's risk on a particular quote is largely a function of the size of the order for which the quote has been requested and the market maker's current position (exposure) in the market.